Experts disagree over whether Mexican President Felipe Calderon will be forced to curb or eliminate the gasoline subsidy. (Photo: Mexican Presidency)        Font Size ..... Small Normal Big Very Big

BY LATIN AMERICA
ENERGY ADVISOR
Inter-American Dialogue

Mexico's costly subsidy for gasoline is becoming even more expensive for the government as global oil prices soar, putting pressure on public finances. What will Mexican President Felipe Calderon do? Will he be forced to curb or eliminate the subsidy? If he does, what would be the economic and political repercussions?

Alejandro Schtulman, Head of Research at Emerging Markets Political Risk Analysis (EMPRA) in Mexico: Back in September 2007, the Mexican Congress approved a new fiscal regime for Pemex, which reduced the fiscal burden on the state monopoly. As a measure to compensate the loss of taxes to the government, Congress approved a minimal monthly increase in the price of gasoline. This announcement prompted widespread speculation and popular discontent. Consequently, President Calderon's ratings suffered a significant decline during the last quarter of 2007—from 66 percent to 57 percent. Calderon's fall in popularity was dubbed as the gasolinazo effect. The recent introduction of gasoline subsidies, along with other measures to contain inflation, aim to preempt the popular discontent that will result from continued rising food costs. It will be difficult, therefore, to think that the Calderon administration will eliminate the current gasoline subsidies, when this measure could help mitigate the impact of rising food prices on his ratings. Further, it can be argued that the removal of gasoline subsidies would make it more difficult for the government to contain rising inflation at this particular juncture. Nevertheless, the subsidies could be removed once sustained progress in controlling inflationary pressures is evident, but this could take up to eight months.

Denise Dresser, Professor at Instituto Tecnologico Autonomo de Mexico (ITAM) and a columnist for Mexico's Reforma newspaper: Felipe Calderon's decision to subsidize gasoline at the cost of approximately $20 billion  a year is bad news. Mexico's president seems to have succumbed to a temptation that proved disastrous for the country's economic management in the past: he is moving from fiscally responsible governance to politically motivated, short-term decision-making. The shift can be attributed to fear of inflation fueled by rising food prices, fear of losing political ground in next year's mid-term elections, and fear of pressure from the left and Andres Manuel Lopez Obrador in the face of mounting economic woes. And while these concerns may be legitimate, the chosen remedy places Mexico on a dangerous path. Mexico limped through successive economic crises over the past three decades, precisely because public finances were placed at the service of political expedience, which translated into price fixing of public goods and services. Today, the Calderon government is using the bonanza created by high oil prices to subsidize the price of gasoline, which the country increasingly imports. As gasoline prices go up, so will the price tag for an ill-conceived subsidy that channels scarce public resources to those able to afford a car. The subsidy amounts to ten times the budget for the National University, half of the annual education budget, five times the budget for the poverty-alleviation program Oportunidades. In a recent speech, Calderon stated that his government addresses issues head on, instead of sweeping them under the carpet. It will be interesting to see how he deals with the enormous elephant in the room that the gasoline subsidy has just made larger.

Nicolás Mariscal, Chairman of Grupo Marhnos in Mexico: The gasoline subsidy in Mexico is a very complex issue, as much because of the solutions needed to resolve it as its social, political, and economic implications. Mexico imports 41 percent of its national gasoline consumption. That makes clear the lack of refining capacity at Pemex. This is due to the lack of investment in development of technology and refinery construction—which in turn is a reflection of the absence of means to manage Pemex with vision—as well as to the changing plans every six years, to legislation that limits many actions, and to corruption that has reduced Pemex's competitiveness so much. After falling behind for more than three decades, the challenge today in closing this enormous gap requires a big investment, as well as time, since the construction of refineries will take several years. President Calderon's energy reform proposal offers a profound transformation of Pemex into an authentic public company, as is the international trend in this area, and encourages private investment in refineries, like in the maquilas, speeding up their construction. If indeed it is true that the subsidy will have to be modified, I don't think it is the strategy President Calderon will choose for now, since this would have great social and political repercussions.

David Shields, independent energy analyst and consultant based in Mexico City: The subsidy is probably not sustainable, as it is fuelling a rise in consumption and imports of gasoline, at a time when Mexico's oil exports are falling. However, President Calderon has said he will maintain it in the short term to dampen inflationary pressures on basic foodstuffs. Since rampant inflation in the 1980s, Mexicans are acutely sensitive to any hint of a rise in gasoline prices, which is taken as the signal for everyone to raise the prices of goods and services. The subsidy is viable for now, without causing a fiscal deficit, as it is being paid for with the windfall revenues from oil exports, which, like gasoline prices, is a political hot potato. Last year, Calderon proposed a minor hike in gasoline prices, but backed down after taking a lot of flak from Congress. So now, he seems intent on pressuring Congress into taking decisions on oil revenues, energy reform, and gasoline prices, as part of the annual debate on the federal budget and public finances, which will come to the forefront in the autumn. After being burned last year, Calderon seems to have decided not to take tough decisions on these issues on his own. However, Congress is not much inclined to take political costs, either, so both sides will probably try to maintain the subsidy until after the 2009 midterm elections.

Rogelio Ramirez de la O, Director of Ecanal economic consultancy in Mexico: The costly gasoline subsidy will indeed put pressure on public finances, even as the government has taken comfort in the fact that it is being granted on the basis of a balanced budget. What makes it threatening to public finances is that gasoline imports, according to [the finance ministry], jumped 34 percent on an annual basis in the first quarter, a pace of increase not matched by the increase in non-oil tax revenue, which fell 2.9 percent through April. One can only speculate what Felipe Calderon may do, but on the basis of his repeated commitment to the gasoline subsidy and other subsidies, he will probably let it continue to expand for all of this year and until the mid-term election, reaching $11 billion and up again in 2009. He would probably try to curb it in the 2009 budget, hoping that he can share some of the negative effect with the opposition. If there were a removal of the subsidy, there would surely be large protests, but this has always been the case with gasoline increases, without having to pose a major political risk. My interpretation as to why he does not remove the subsidy or reduce it substantially is that his reading of social tolerance for price increases is much more pessimistic than I would have imagined.

Republished with permission from the Inter-American Dialogue's weekly Latin America Energy Advisor newsletter.